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'Demand certificates' proposed for futures contracts

The National Grain and Feed Association says forcing managed index and pension funds to “take delivery” on commodities such as wheat may be one way to solve the lack of convergence on Chicago Board of Trade futures contracts.

The NGFA said it was not recommending adoption of the practice yet, but is establishing its own task force to analyze the concept of “demand certificates,” under which the maker of delivery could compel load out of the underlying commodity.

Although Chicago Board of Trade soft red winter wheat futures have been trading at record levels the last two years, farmers and elevator managers have said a weak basis — the difference between cash prices and futures — has left them with cash prices $1 to $2 per bushel below futures prices, particularly at harvest.

This lack of “convergence,” the narrowing of the gap between cash and futures can be partly blamed on the growing influence of speculative interests — primarily pension and index funds — in the futures markets, the National Grain and Feed Association says.

The NGFA noted that index and pension funds controlled about 60 percent of CBOT wheat futures contract open interest — a share that represents about 1.5 times the size of the entire U.S. soft red winter wheat crop — in mid-September.

“The disproportionate participation of this investment capital relative to total participation in CBOT wheat futures has been the primary factor leading to deterioration in its performance,” National Grain and Feed Association officials said in a response to the CME Group’s proposed changes to its CBOT wheat futures contract.

NGFA officials said they have previously cited the infusion into agricultural commodity futures markets of large amounts of capital from passively managed index and pension funds that take long-only positions as a major contributor to futures price volatility and market disruption.

Entities taking a “long” futures market position have bought futures or options contracts, but have not offset those purchases with a cash market position in the underlying commodity. (A farmer or grain merchant, in contrast, may buy or sell futures as a hedge but also sell in the cash market.)

The NGFA said a compelled loadout “may be part of the solution” to enhancing convergence in the CBOT wheat futures contract and preventing the widening of the basis that has drawn farmer complaints the last two seasons.

“Certainly, some period of time to analyze the structure of such a change and how to implement compelled loadout would be needed,” the NGFA said. “Given the urgency of the situation and the need for solutions, we would urge that consideration be expedited and brief to evaluate whether compelled loadout is the right course.”

The NGFA said its task force would further develop the details of the compelled loadout concept with the goal of maintaining contract balance and functionality “so that long hedgers would not be inadvertently driven out of the contract because of unacceptable levels of risk.” Calling the CME Group’s proposals “a good first step,” the NGFA said much more dramatic and substantive changes need to be made to restore the integrity and functionality of the soft red winter wheat contract.

The CME Group’s proposals would implement three changes to the CBOT wheat futures contract — seasonal storage rates; additional grain elevator delivery locations for CBOT wheat at market-based differentials; and tighter limits on deoxynivalenol (vomitoxin) in wheat eligible for delivery to satisfy outstanding futures contracts. The changes require approval by the Commodity Futures Trading Commission following a public comment period.

The NGFA said it does not believe the changes alone would be sufficient to achieve convergence in the CBOT wheat futures contract, which it said “may be at risk of failing if current trends continue.”

It said it was encouraging the CME Group to research and design new alternatives to the current CBOT wheat contract because “ultimately, the continued dominance and ever-increasing share of open interest held by investment capital may make it difficult to achieve convergence on a consistent basis.”

The NGFA is recommending the CME Group explore creating a new world wheat index contract, a U.S. wheat index contract comprised of all wheat classes, or some other index product that could be used by investment funds wanting to buy wheat futures contracts as part of an investment portfolio, and which potentially could operate side-by-side with the current CBOT wheat contract that could be used by traditional hedgers.